Feelings Are Not Mutual in 401(k)s

By CARLA FRIED and DIANA B. HENRIQUES

Published: November 16, 2003

EMPLOYEES saving for retirement can't seem to catch a break. After nearly three years of painful bear-market losses, 2003 was shaping up as the year of the rebound, as a stock rally finally lifted portfolio values.

But before 401(k) investors could fully enjoy the fat returns on their third-quarter statements, revelations of improper trading by insiders and a few favored investors began to raise fundamental questions about the trustworthiness of mutual fund managers.

So what should the people who run and advise 401(k) plans do? Unfortunately, there are no simple answers. Some of the remedies being bandied about may be just as harmful to investors as the misdeeds at the heart of the spreading scandal.

But one thing has become increasingly clear: staying on the sidelines until the dust settles is no longer an option for 401(k) plans, which have entrusted an estimated $690 billion to mutual funds.

"Given the number of red flags, you cannot just sit on your hands and whistle in the dark and say, 'Gee, I hope none of the funds we've got are doing any of these things,' '' said Eli Gottesdiener, an employee benefits lawyer in Washington. "Your duty is to pick up the phone - you call up, you ask questions and you get answers, or you move" from the fund company, he said.

A survey last week by Plan Sponsor magazine showed that more than 16 percent of respondents had already dropped a fund or a fund management company from their plan, and nearly 13 percent said that they were at least considering that step.

"The recent news brings a new set of facts to the table," said Ann Combs, assistant secretary for employee benefits security at the Labor Department. For 401(k) plan sponsors, Ms. Combs said, "your responsibility is not just to select the funds but to monitor them."

In the last few weeks, several companies have cleansed their plans of funds managed by Janus Capital and Putnam Investments, both of which have been implicated in the scandal.

Microsoft told employees that as of Friday, the Janus Balanced and Janus Worldwide funds would no longer be offered in its 401(k). Standard Insurance in Portland, Ore., has dropped the Janus funds in its plan, too.

Alaska Airlines and Nordstrom, the department store chain, have taken a more cautious approach. Nordstrom says it intends to dump the Putnam International fund, which regulators say was involved in abusive trading, but will continue to offer five other Putnam funds that have not been implicated in the accusations of improper trading.

"We are taking a look at our whole relationship with Putnam,'' said Shasha Richardson, a Nordstrom spokeswoman. "We want to have all the facts before we make any decisions. But we did want to act on Putnam International in the best interests of our employees."

Alaska Airlines has announced that it is removing Putnam as the administrator of its retirement plan but will retain five Putnam funds in its 401(k), supplementing them with offerings by other companies.

RESPONDING to the scandal, however, can be more complex than plan sponsors may think. Consider the problem facing DuPont. As of Friday, the company closed two Janus funds to new investments, at least temporarily, said Tara Condon-Tullier, a company spokeswoman.

But the plan also offers a number of Merrill Lynch funds. And Merrill notified DuPont that DuPont employees might have been trading improperly in two of those funds. At Merrill's request, DuPont required employees to hold shares in the two funds for at least 15 days.

Then DuPont checked further and discovered similar problems in three other funds. So it prohibited frequent trading in them, too.

"Our whole focus is to protect all DuPont participants, which is why we have imposed these trading restrictions," Ms. Condon-Tullier said.

Other companies are determined to wait a while longer before deciding whether to take action. Ms. Combs, of the Labor Department, said that plan sponsors face a "delicate situation." Federal law requires that plans be operated solely for workers' benefit. "But in the end it is still a judgment call," she said.

Lawyers who advise plan sponsors say that every plan must carefully monitor regulatory and criminal investigations as they unfold - and keep a meticulous record of how they reach any decision. "Keep communication logs, document everything that's going on, keep a record of what you considered," said Carol McClarnon, an employee benefits lawyer at Sutherland Asbill & Brennan in Washington. "There isn't a right or wrong answer, at least at this point in time," she added. "But we're trying to encourage people to be really good about documenting how they reached whatever answer they made."

Some experts caution against hasty action. "We are just in the early stages of understanding the scope of the problem, and what the reforms and restitution will be,'' said Matthew Gnabasik, an employee benefits consultant in Chicago and the author of "Smart Choices: Selecting and Administering a Safe 401(k) Plan." (Blue Prairie Group, 2002). "Jumping to make a move now may not be in the best interests of the investor or the plan sponsor."